Blockchain: What Does It Mean for Banks and Fintech?

The financial sector has long been subject to technological changes and innovations. In recent years, blockchain technology has emerged as one of the most promising innovations within the financial sector.

Blockchain is one of the key technologies that modern fintech applies in order to transform any smartphone into “the bank into pocket”, blockchain galvanizes the process when people trust more and more AI assistants on the secure base. The terms blockchain and DLT are often used synonymously, but in reality, blockchain is a type of DLT.

DLT

Distributed Ledger Technology (DLT) has several definitions, but it is most commonly accepted as a distributed ledger. It is an innovative database that is shared by nodes within a network as a way to transform payment, clearing, and settlement processes. By adding new blocks to the chain that represent transactional data, this type of DLT can chronologically and cryptographically show events and changes.

DLT software is managed by entities called nodes that collectively maintain the database records. The nodes are connected to share and verify the information. This structure allows all entities with a node to take on database management responsibilities directly with each other on a peer-to-peer basis. This differs from traditional database architectures where only a central entity serves as the source of information and control.

The Main Challenges the Banks Face

Today, banks face several challenges such as fraud, operational risks, efficiency limitations, and transaction delays. The potential improvements that can be made in the sector with the help of the technology include cost minimization, more efficient transactions, increased security, and enhanced customer experience. The blockchain is the main answer.

Blockchain technology is a technique that enables secure sharing of information by continuously updating and sharing it with a network of participants. A blockchain consists of datasets that are composed of a chain of data packets, known as blocks. Each block is encrypted with a unique hash, creating a chain of cryptographically secure information.

The technology has three main characteristics:

• cryptographic security,
• a digital transaction log, and
• a shared database across the network

This chain can then be used to provide an overview or ledger of the transaction history. New blocks do not overwrite old blocks; instead, they are added to the chain, allowing events to be visible over time. This creates a perfect audit trail that allows insight into previous versions of the blockchain. The blocks are validated by the network using cryptographic methods to verify that the information provided matches that of the network.

When new blocks are created, the legitimacy of the new data must be confirmed and verified based on the consensus method. Once this occurs, all nodes are updated to reflect the events.

In addition to information about the content of the transaction, each block has a timestamp, the hash value of the previous block known as the 'parent', and a randomly generated verification number.

The Benefits

The improvement potential within the sector primarily lies in areas with a high degree of manual paperwork and a need for many intermediaries.

This innovation contribute to reduced transaction costs and time in trade finance due to the automation of the chain, increased transparency between financial actors and authorities, reduced transaction costs and time for KYC services, as well as ensuring the authenticity of information, automating transactions and processes for ownership transfer, streamlining and simplifying record-keeping, and digitally storing documents. The technology has the potential to enhance the efficiency of banks' internal processes.

The Setbacks

In many countries there is a lack of regulations that can guide the use and implementation of the technology, as well as a lack of global standards. Security risks are also on the table.

Additionally, there are uncertainties about whether a completely decentralized system can be practically implemented, as several use cases require a certain degree of centralization, particularly within the financial sector.

One of the biggest challenges is finding suitable use cases where blockchain can offer real advantages compared to existing solutions. The challenge lies not only in identifying technically feasible solutions but also in convincing stakeholders to abandon current systems in favor of blockchain technology.

The Practical Cases

The initial hype surrounding the technology has matured into a more realistic perspective, with an increased understanding of the technology. The difference may stem from a deeper understanding of the technology's advantages or a more innovative corporate culture among banks and financial institutions in different countries.

Some cases include when banks use blockchain for digital payments and tokenized deposits. Insurance documents can also be placed on a blockchain. Just an example. The bank operates in many different countries, and some countries have specific regulations that make the contract valid only after payment is made. This creates a period of uncertainty regarding whether the contract is valid, as it is not possible to see if the payment has actually been made. Blockchain technology provides the relevant transparency in this case.

Blockchain is very useful when there are more than two parties involved in a contractual relationship. It provides a unified "information screen" that allows all parties to see changes to document status in real-time.

Tokenization is the next big thing related to blockchain implementation. Tokenization is the process of converting various assets into digital tokens on a blockchain. Several leading global companies and organizations, such as BlackRock, Société Générale, НSBC, are actively exploring tokenization opportunities.

But the issuance of digital bonds (not just tokenized bonds) is already a case. In September 2024, Siemens launched a €300 million digital bond utilizing the private permissioned blockchain SWIAT. This issuance marked a significant milestone as it incorporated the Bundesbank's Trigger Solution, enabling the settlement of a Siemens bond in a fully automated manner for the first time, completing the process in mere minutes. The bond attracted investments from prominent financial institutions, including BayernLB, DekaBank, DZ BANK, Helaba, and LBBW, with Deutsche Bank facilitating the settlement.

In contrast, last year, Siemens issued a €60 million digital bond on the Polygon blockchain, which required two days to finalize all contractual procedures.

So this time, blockchain proves the thesis that practice is the best teacher. As banks and fintech companies increasingly apply blockchain, they discover ways to reap more benefits from it.

The future lies in the development of blockchain-based financial infrastructure to scale up the use of this technology and bridge the eagerness to use this innovation, which is profoundly visible among numerous banks and fintech companies worldwide, with all kinds of investors. This will spur the development of a blockchain-driven financial world.